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Market takes $680 million Target write-down in its stride

Eli Greenblat

Analysts say no one should have been surprised by Wesfarmers' Target-fuelled writedown.

The $680 million writedown pinned to Target shouldn't come as a surprise given the business' poor financial performance over the past few years, with the merchandise and apparel chain arguably the weakest performing division scooped up by Wesfarmers when it bought Coles in 2007, analysts said.

The impairment charge, unveiled on Wednesday along with a $94 million provision for fiscal 2014 to fix Coles' struggling liquor arm, came as investors eagerly anticipate news from the Perth-based conglomerate of a capital return after the recent sale of the group's insurance operations leaves it with an estimated $1.7 billion in cash sitting on its balance sheet. A major acquisition, especially of an overseas asset, is also a strong possibility.

''Based on past practice, it is likely that a special dividend of around $380 million [34 cents per share] will be declared to distribute franking credits created from profit generated from the insurance sale,'' said Credit Suisse analyst Grant Saligari.

''There is probably an equal potential for remaining proceeds, around $1 per share, to be used for acquisition or to fund a capital return.''

UBS analyst Ben Gilbert tips Wesfarmers to mail back $1.5 billion to shareholders, equivalent to about $1.30 per share.

''In the absence of an acquisition in the next six months, we expect Wesfarmers to return excess funds to shareholders.''

In the meantime, shareholders will have to wear the cost of the impairment charges triggered by the continued stumbling of Target as it pushes through a transformation program in the midst of one of the toughest trading conditions for discretionary retailers for many years.

Analysts took the non-cash hit to Target's valuation in their stride on Thursday, saying the decision to wipe off 35.2 per cent of Target's carrying value was not a huge surprise given the retailer's very public ills.

''This is not particularly surprising given Target's recent performance, the competitive environment and the fact that Wesfarmers' 2013 annual report explicitly stated a reasonably possible change in the discount rate and trading conditions could result in the carrying value of the division exceeding its recoverable amount,'' said Macquarie Research Private Wealth in a note to clients.

Macquarie values Target at $1.5 billion to $1.7 billion, well below the $2.4 billion value placed on the business by Wesfarmers.

Mr Saligari said Wesfarmers' guidance that Target would post earnings of $82 million to $88 million for fiscal 2014 implied a small 2 per centage points lift in margins and indicated the likely completion of excess inventory clearance and a clean start for 2015 for Target boss Stuart Machin.

''With that legacy issue behind it, there is a better chance that Target will improve its merchandise assortment and, as a result, establish a better base for sales growth,'' Mr Saligari said.

He said there was a reasonably sure step-up in earnings to around $170 million in fiscal 2015.

Target recorded pre-tax earnings of $136 million for fiscal 2013, down from $244 million in 2012. Mr Machin is 12 months into a complete restructure of the retailer by reshaping its store network, rationalising product ranges, improving customer offer and increasing operational efficiency.

JP Morgan analyst Shaun Cousins said Target had suffered from increased competition from Wesfarmers stablemate Kmart and a lack of innovation.

''We suggest the Target turnaround is long-dated and more difficult than Coles.''

He said Mr Machin's transformation plan seemed ''quite sensible and well considered''.